‘A big mistake’: Lessons from the JPMorgan-Frank fintech deal

Millions of fake students. An $18,000 payout to create synthetic identities. Emails revealing the possibility of “orange jumpsuits” revealed panicked cover-ups.

Bank fintech acquisition buzz rarely has details as salacious as the saga of JPMorgan Chase and Frank. Earlier in January, news broke about a lawsuit that JPMorgan Chase filed on Dec. 22 alleging that it was scammed by the founder of Frank, a college financial planning website like that acquired in September 2021. The bank paid $175 million to acquire Frank on the condition that it had 4.25 million customers with accounts. In reality, the vast majority were fabricated, according to the complaint, and there were fewer than 300,000 real users. Charlie Javice, the founder of Frank, filed his own lawsuit against Chase the next day, countering that Chase launched “baseless investigations” into her conduct to deny her the compensation it owed her, including a $20 million retention award.

Other bank-fintech deals have collapsed in the past year, such as UBS bid to merge with automated wealth management firm Wealthfront and Patriot National Bancorp’s deal for the neobank American Challenger Development Corp. But none have made the headlines or sparked as much curiosity as the Chase-Frank story.

It raises questions about what the bank could have done differently during due diligence and why troubling aspects of Frank’s past didn’t give pause sooner. Observers point out that there were warning signs from years ago, including investigations by the Department of Education and the Federal Trade Commission.

There are also broader lessons for banks targeting fintech for acquisitions, from the importance of balancing speed with due diligence and the need to carefully weigh how a startup’s future will look in a legacy institution.

“Entrepreneurs become these media stars,” said Mathieu Shapiro, managing partner at law firm Obermayer, who compared the rise and fall of Frank to the scandals surrounding health-tech company Theranos and cryptocurrency exchange FTX. “When you have the whole world talking about how good they are, it becomes more difficult to stand up and say this doesn’t count, what are they actually doing to make the loan process easier?”

At JPMorgan fourth quarter conference call, CEO Jamie Dimon described the acquisition as “a big mistake”.

In an emailed statement, JPMorgan Chase spokesman Pablo Rodriguez said: “Our legal claims against Ms. Javice and [Frank’s chief growth officer] MR. [Olivier] Amar is described in our complaint, along with the most important facts. Any dispute will be resolved through the legal process.” Attorneys for Charlie Javice did not respond to a request for comment.

Warning sign

“There’s a balance in any acquisition between speed to close and the competitive environment, making sure you do the right due diligence, where what you’re buying will create the outcome you’re looking for,” said Michael Berman, CEO of Ncontracts. which produces risk management software for financial institutions. “Sometimes people put speed before diligence.”

There are three main reasons why banks seek fintech acquisitions, said Pieter van den Berg, managing director and partner at consulting group BCG. Institutions may want to have a specific capability they are betting they can achieve more quickly through an acquisition; they may want to absorb the talent in fintech; or they may want the company’s customer base or revenue.

“Often there are several factors,” said van den Berg.

In its complaint, JPMorgan Chase noted that college students represented a market it wanted to reach better. It cited the 4.25 million customer count as a sign that Frank was “deeply engaged in the college-age market segment.”

“We want to build lifelong relationships with our customers,” said Jennifer Piepszak, co-CEO of Chase, in a September 2021 press release announcing the acquisition. “Frank offers a unique opportunity for deeper engagement with students.”

Observers reading JPMorgan Chase’s complaint wondered if there were any important steps the bank missed in its due diligence.

One investigated Frank’s claims about the number of students it helped.

“If Frank’s primary function was to get people through the financial aid application, and Frank promised JPMorgan Chase that their account holders included [4.25] million people, that would be a quarter of all financial aid applications in America, depending on how you measure it,” said Mike Pierce, CEO and co-founder of the Student Borrower Protection Center, a nonprofit that focuses on student debt. The market to applying for financial aid is not that big.”

Pierce notes that there is a long history of fraud associated with helping students prepare applications. One example is the website FAFSA.com, which charged students money to help them complete the Free Application for Federal Student Aid, also available on FAFSA.gov.

“There should always be skepticism about how these private firms make money from what is supposed to be a free application,” he said.

The Federal Trade Commission and the Department of Education also issued warnings. In 2017, the Department of Education accused Frank for trademark infringement on FAFSA; Frank settled in 2018. In 2020, the FTC flagged several misleading statements on Frank’s website in a warning letter. One was the claim that consumers can get a cash advance of up to $5,000 for “No interest, no fees – ever,” despite Frank charging a fee of $19.99 per month.

Berman points to two aspects of due diligence that he feels are critical: experiencing the customer journey firsthand, perhaps by paying a third party to test the platform, and assigning a risk and compliance team to scour the site for claims that sounded too good to be real. After reading through the complaint, he is unsure to what extent Chase followed this practice.

In its complaint, Chase describes the steps it took, including reviewing a spreadsheet of 4,265,085 individual students who were allegedly customers of Frank and sending an email requesting specific details to back up the number of alleged users. After Javice refused to submit emails and home addresses for privacy reasons, Chase agreed to use a third-party data processing provider, Acxiom, to validate Frank’s customer information. Observers agree that it is unclear from the complaint how Acxiom failed to disclose that much of that data was invented by a “computer professor” that Javice hired. Acxiom did not respond to a request for comment.

“What two entities decide to accept in terms of respecting privacy, coming up with a confidentiality agreement, letting a handful of people look at the actual data or not — that’s all part of the negotiation process,” Shapiro said. “There may be reasons why Javice wanted to insist on privacy, and then it’s up to the purchaser to say, am I willing to go forward with the information I would otherwise have received?”

Takeaways for future acquisitions

The alleged fraud rampant in this case may be an outlier in the world of banking fintech acquisitions. But many such acquisitions happen more quietly.

In an analysis of publicly announced acquisitions, BCG found that for all deals made by financial institutions globally between 1980 and 2018, with a deal value of $250 million or more, 54% failed to create value based on relative total shareholder return over the first 12 months after the agreement was announced.

A 2019 global BCG survey of 277 cross-industry executives overseeing integrations found that the top two reasons why acquisitions failed to deliver value were poor integration approach (46%) and poor strategic alignment (42%).

“Banks need to think through the requirements for a fintech to thrive in the bank,” said van den Berg.

That means weighing the pros and cons of keeping fintech as a stand-alone, adjacent or fully integrated business within the bank. Problems can arise when new employees become restless or the sales team is not properly motivated to sell a new product.

“If you want to buy a fintech for talent, that talent [could] start walking out the door the moment they have an opportunity because they don’t want to be part of a bigger bank,” said van den Berg. “When a bank wants to cross-sell products to its existing customer base, it often is. harder to implement than it looks, because the bank’s salespeople may be unfamiliar with the solution and may not prioritize it as much as the core products.”

But keeping the company as a stand-alone entity “could potentially hamper you in terms of what kind of synergies you get from that,” he added.

Banks may struggle to integrate new technology into an older platform. There is also the question of how well a bank’s appetite for risk jibes with a startup’s hunger for growth.

“Successful fintechs are successful because they keep innovating,” said van den Berg.

Pierce wonders if a similar story could play out again as fintechs and edtechs potentially seek an “escape route” through banks when funding is harder to come by. At the same time, banks may be eager to tap into this startup segment, as Chase was, to strengthen connections with students. Banks stopped making federal student loans in 2010 as part of the Health Care and Education Reconciliation Act.

“It’s been a boom-and-bust cycle in banks that serve students,” Pierce said. “I think [banks] are just beginning to understand what it means to not have long, deep banking relationships with an entire generation of college-educated Americans, as they had the generation before and the generation before that.”

He points out that there could also be more victims if history repeats itself.

“Frank was brash in a way that makes it a good story to tell in part because these users were fake, so it’s not like you have students with money on the prowl,” Pierce said. “I hope next time it’s not a story about how families were fleeced by fraudsters and big banks.”